Trade Secret and Unfair Competition Employment Issues

Protecting Trade Secrets is critical for business success. This presentation will provide a general overview of trade secrets

and unfair competition in the work place and provide some tools for companies to safeguard trade secrets and mitigate potential risks.

Trade Secrets Unfair Competition Methods/Strategies

What We Will Cover

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TRADE SECRETS 1

Definition

There are two primary sources for defining trade secrets:

1. Statutes based on the Uniform Trade Secrets Act (UTSA), which many states have adopted with various twists, and

2. Common law factors traditionally used by courts in various jurisdictions to identify confidential business information. The UTSA is codified in California at CC §§3426–3426.11. Under the California UTSA, a trade secret is defined as follows (CC §3426.1(d)):

[I]nformation, including a formula, pattern, compilation, program, device, method, technique, or process, that:

1. [d]erives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use, and

2. is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

What Are They?

Forever!

Or ….

Until disclosed, reverse engineered, or becomes partof the public domain (i.e. How long you can keep it secret).

How Long Does It Last?

• Marketing Strategies

• A Formula for a Sports Drink

• Survey Methods Used by Professional Pollsters

• Recipes

Examples

• A New Invention for Which a Patent Application Has Not Yet Been Filed

• Manufacturing Techniques

• Computer Algorithms

Benefits

• Preserves Competitive Advantage Indefinitely (At Least Until The Secret Is Discovered).

• Free – Sort Of (At Least Until Enforcement).

• Maintaining Secrecy Does Not Have To Be Expensive.

• May Be Available When Patent Is Not.

• Increasingly Difficult to Keep Information and Processes Secret.

• Difficult (But Sometimes Not Impossible) to Put The Genie Back In The Bottle If Disclosed.

• Must Be Identified With Specificity and Precision.

Drawbacks

Establish misappropriation (UTSA section 1(2)) generally requires:

• Trade Secret acquired by “Improper Means” (theft, bribery, misrepresentation, breach of duty to maintain secrecy, espionage)

• Unauthorized disclosure without consent under circumstances which give rise to duty to maintain secrecy or limit use

Enforcement

Proper means include:

1. Discovery by Independent Invention;

2. Discovery by "Reverse Engineering", that is, by starting with the known product and working backward to find the method by which it was developed. the acquisition of the known product must, of course, also be by a fair and honest means, such as purchase of the item on the open market for reverse engineering to be lawful;

Proper Means

3. Discovery Under a License From The Owner of The Trade Secret;

4. Observation of The Item in Public Use or on Public Display;

5. Obtaining The Trade Secret From Published Literature.

UTSA

Money Compensation for the Misappropriation

a. Loss to trade secret owner;

b. Unjust enrichment of the one who misappropriated, if that is higher than the loss to the trade secret owner.

Damages may be measured by imposition of a royalty for the use.

Remedies - Civil

In the case of willful and malicious misappropriation, punitive damages up to twice the actual damages.

Injunctive Relief

a. Prohibiting use or disclosure

b. Requiring return or destruction of confidential information

Both state and federal statutes make theft of trade secrets a crime.

Remedies - Criminal

California Penal Code Section 499c

Fine of up to $5,000.00, imprisonment of up to a year, or both.

18 U.S. Code Section 1832 (Economic Espionage Act of 1996)

For an individual, fine of up to $500,000 or imprisonment of up to ten years or both; for an organization, fine of up to $5,000,000.

• Common Law Shop Rights or “Peck Rule”

• Confidentiality and Assignments of Inventions Agreement

Employer’s Right to Patents and Trade Secrets

UNFAIR COMPETITION2

The term “unfair competition” now describes an array of legal actions addressing methods of competition that improperly interfere with the legitimate commercial interests of other sellers in the marketplace, including actions for passing off, deceptive advertising, and the infringement of trademarks. – Restatement of Law, Third, of Unfair Competition, American Law Institute.

Definition

• Interference with Prospective and Existing Contractual Relations

• Product, Service and Business Misidentification

• Appropriation of Intangible Business Assets

- Appropriation of Trade Secrets and Ideas

What Is It?

• Injurious Promotional Practices

• Injurious Pricing Practices

• Generally – Anti-Competitive Behavior

• As Between Companies and Former Employees

• Solicitation of Customers/Employees

• Organization of a Competing Business

• Computer Fraud and Abuse Act (CFAA)

Examples

• Business and Professions Code §16600 provides as follows:

- “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.”

• California courts have declared this section to be an expression of public policy to ensure that citizens of California retain the right to pursue any lawful employment and enterprise of their choice.

As Between Company and FormerEmployee NON-compete Agreements

• Covenants Not To Compete Are Generally Invalid

• Employees Can Quit And Compete

• Limitations Imposed By Trade Secret Laws

Examples > As Between Company and Former Employee

However, covenants not to compete may be enforceable when given by:

• Any person selling the goodwill of a business under appropriate circumstances. Bus & P C §16601. Any equity owner of a business selling or otherwise disposing of all of his or her ownership interest in the business. Bus & P C §16601. See, e.g., Hilb, Rogal & Hamilton Ins. Servs. v Robb (1995) 33 CA4th 1812, 1824; Vacco Indus., Inc. v Van Den Berg (1992) 5 CA4th 34.

• A member of a limited liability company (LLC) on dissolution of the LLC or a sale of the member’s interest in the LLC. Bus & P C §16602.5.

• Any equity owner of a business that sells (1)all or substantially all of the operating assets and goodwill of the business or of a division or subsidiary of the business or (2) all of the ownership interest of a subsidiary. Bus & P C §16601. But see Hill Med. Corp. v Wycoff(2001) 86 CA4th 895 (covenant not within exception not enforced).

• A partner on dissolution of the partnership,the partner’s withdrawal from the partnership, or disposition of the partner’s interest. Bus & P C §16602; Howard v Babcock(1993) 6 C4th 409.

Examples > As Between Company and Former Employee

• Contract Not to Solicit Customers by Former Employee

• Contract Not to Solicit Company Employees by Former Employee

Solicitation of Customers/Employees

“Solicitation”

- Requires Active Requests or Appeals

- Passive Acceptance of Business Not Enough

Enforceability

- During and After Employment

- Even When Not Tied to Trade Secrets?

Remedies For Breach

- Damages

- Injunctive Relief

Examples > Solicitation of Customers/Employees

Nondisclosure Agreement

• California permits covenants to prevent the misappropriation of trade secrets and unfair competition. In general, the employer can only restrain a former employee’s conduct by contract to the extent that the same conduct would be subject to judicial restraint under the law of unfair competition.

• One California appellate court held that Business and Professions Code section 16600 does not invalidate an employee’s agreement not to disclose his or her former employer’s confidential customer lists or other trade secrets.

• To be enforceable, the non-disclosure agreement must still be reasonable and narrowly tailored. California courts will not “save” an overly broad agreement by limiting it only to unlawful conduct.

Examples > Solicitation of Customers/Employees

• A no re-hire provision is one in which the employee gives up his or her right to be hired again by the employer and which prohibits the employee from applying for re-employment.

No Re-hire Agreements

Examples > Solicitation of Customers/Employees

• Generally, an Employee May Leave a Company and Organize a Competing Business.

• Within Limits, He or She May Take Steps Prior to Termination of Employment

• Not Entitled to Compete During Employment (e.g. solicit customers)

Organization of a Competing Business

Examples > Organization of a Competing Business

• 'An employee is subject to liability if, before or after leaving the employment, he causes fellow employees to break their contracts with the employer; On the other hand, it is normally permissible for employees' of a firm or for some of its partners, to agree among themselves while still employed, that they will engage in competition with the firm at the end of the period specified in their employment, contracts. However, a court may find that it is a breach of duty for a number of the, key officers or employees to agree to leave their employment simultaneously and without giving the employer an opportunity to hire and train replacements.'

Examples > Organization of a Competing Business

• 18 U.S.C. 1030 (1984)

• Provides private cause of action against any individual who accesses “computer systems” to obtain information without authorization or exceeds authorized access

• Automatic federal jurisdiction

Computer Fraud and Abuse Act (CFFA)

• No requirement to establish theft of trade secret or even that trade secrets were involved

• Can be used to supplement trade secret claim

• Allows for injunctive relief and attorneys’ fees

Examples > Computer Fraud and Abuse Act (CFFA)

• “Protected computer” is broadly defined to mean a computer “used in interstate or foreign commerce or communication.”

• In most contexts, violation must “cause[ ] loss aggregating at least $5,000 in value during any 1-year period to one or more individuals.”

• Courts are split on whether “without authorization” or “exceeds authorized access” applies to the disloyal employee within the organization.

• The 2nd, 4th and 9th Circuits found that the “exceeds authorized access” cannot apply to disloyal employees.

• The 7th and 11th Circuits do apply the CFAA to disloyal employees.

• Legislation has been recently proposed to resolve the circuit split:

- In 2013, Rep. Zoe Lofgren (D. Cal.) proposed an amendment to narrow the scope of the CFAA and clarify the “unauthorized access” language. See H.R. 2454 (proposed).

- The amendment would clarify that the law only applies to hackers – not to employees violating computer use policies.

Examples > Computer Fraud and Abuse Act (CFFA)

• Clearly defining an employee’s scope of authorized access may allow an employer to maintain a CFAA claim.

• Include provision in confidentiality agreement that employee is not authorized to access company computers for “personal gain.”

• Make clear the types of access that are “unauthorized.”

Define “Authorized Access” in Employment Agreement

Examples > Computer Fraud and Abuse Act (CFFA)

METHODS / STRATEGIES3

• Control Access to Company Trade Secrets and Confidential Information

• Address Employment Relationships

• Requiring Confidentiality Agreements With Employees

“Reasonable Measures” to Protect Trade Secret

• Requiring Non-disclosure Agreements With Customers and Third Parties

• Having Written Confidentiality and Computer Use Policies in Place Within the Organization

• Limiting Access to Information Within The Organization

• Password Protection or Tiered Access To Electronic Information

• Regulating Visitor Facility and Premises Access

• Conduct Pre-hire Investigation

• Analyze Competitors’ Business and Potential Employee’s Duties There

• Warn Potential Employee Not To Take Computer Files Or Documents Upon Departing

• Include Trade Secret Warnings In Offer Letters, Employment Agreements and Other Documents

• Restrict access to servers, routers, and other network technology to those whose job responsibilities require access.

• Keep wire closets, server rooms, phone closets, and other locations containing sensitive equipment locked at all times.

Control Access to Trade Secrets and Confidential Information

• Place locks on computer cases to prevent hardware tampering.

• Lock file cabinets and offices that store sensitive information. Consider having sign-in and sign-out sheets for files to establish a traceable chain of custody for files that shows who had the files last before any alleged misappropriation.

• Designate all documents containing trade secrets or confidential information as “confidential” and implement procedures to help ensure that all documents deserving the “confidential” designation are appropriately marked when initially created.

• Implement password protocols for all employees for purposes of access to all critical system resources. Specifically, do not let employees pick theirown passwords, because they will pick passwords reflective of things about themselves that are easily discoverable (e.g., spouse’s name, pet’s name). Instead, assign passwords that are a series of random letters and numbers (there is software available to create these), and change these passwords atregular intervals (e.g., every 10 to 30 days). Have a policy that prohibits sharingof passwords among employees. Have a policy that requires the immediate deletion of an employee’s password and all of that employee’s network accessrights on an employee’s termination or resignation from the employer.

• Have a policy that permits the employer to monitor and log employees’ Internet actions. The policy should provide for employee consent to the employer’s inspection of an employee’s home or other personal computer(s) and electronic storage devices to recover the employer’s confidential and trade secret information if necessary.

• Keep audit logs of all access requests to critical systems and sensitive information.

• If the company’s network is on the Internet, use a firewall, audit the servers for security holes on a regular basis, and make sure that the system has all of the latest security patches and fixes installed.

• Back up all workstations and servers at least weekly and store backups off-site.

• Periodically test the backup system to ensure the ability to restore data if necessary.

• Train employees not to discuss the company’s trade secrets or confidential information around third parties.

• Utilize confidentiality provisions in contracts with any third parties (such as vendors and customers) that the employer permits to see its confidential information or trade secrets.

• Nondisclosure Agreement. Have each employee sign a nondisclosure/confidentiality agreement. A nondisclosure/confidentiality agreement accomplishes a variety of goals, the most important of which is that it acknowledges that the employee has been or will be exposed to certain company trade secrets and other confidential and proprietary information.

Employment Relationships Nondisclosure Agreement

• Ensure that the nondisclosure/confidentiality agreement contains a non-solicitation provision. A non-solicitation provision prohibits a departing employee from soliciting, directly or indirectly, the company’s customers or clients through the use of confidential or trade secret information, regardless of where they are located, to do business with the employee.

Employment Relationships Non-solicitation Provision

Employees Hired from a Competitor Guidelines

• Provide Guidelines to all newly hired employees who had access to their former employers’ confidential or trade secret information.

• The Guidelines are intended primarily for individuals in sales and other customer services-related positions.

• The Guidelines can either be given to an employee, with the employee then acknowledging receipt, or made part of the employee’s training by the employee’s manager(s), or both.

• The benefit of utilizing these form guidelines is twofold: (1) They create positive evidence of the employer’s policy of fair competition, and (2) they evidence the employer’s intent to avoid use of the former employer’s confidential or trade secret information when the new employee communicates with customers or clients that the employee did business with while employed by his or her former employer.

• Importance of Exit Interview

• Guide for Employer Exit Interview

• Certificate of Compliance Post-Termination

Exit Interview

• In order to be entitled to protection of its confidential and trade secret information, an employer must be able to demonstrate that it took reasonable measures to ensure the secrecy of the information that the employer seeks to protect. See CC §3426.1(d).

• The employer must be able to demonstrate that it exercised reasonable measures to (1) prevent the employee from taking confidential or trade secret information to a competitor and (2) recover the information from the departing employee, regardless of whether the information is in paper or electronic form.

• The establishment of exit interview protocols as a pattern and practice of the employer creates positive evidence of the required reasonable measures, even if the departing employee actually misappropriates confidential or trade secret information.

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